Cyprus And The Eurozone Bank Bailout Hypocrisy

Cyprus didn’t prick the Eurozone bailout bubble, the notion that bank investors who took enormous risks to gain financial rewards would always be made whole by taxpayers. That bubble had been pricked in February. But it was the first time that the international bailout cabal, the Troika, stuck its needle into it—while Germany quietly bailed out all investors in one of its own rotten banks.

The bailout deal was pretty slick; it dodged the Cypriot parliament which had demolished the prior package. Well-honed Eurozone tactics: don’t allow voting to mess up the plans. Uninsured depositors would eat €4.2 billion—much of it Russian money. Junior and senior bondholders would kiss their €1.7 billion goodbye. That even senior debt, albeit only €200 million, was destroyed was a first in Eurozone history. Eurozone taxpayers would pick up the remaining €10 billion—still a lot for such a tiny country, but at least it wouldn’t be pocketed by some hedge funds, or worse apparently, Russian depositors.

In return, the country won’t go bankrupt. Not for the moment, at least. But no one knows how Cyprus can rebuild its economy without its outsized banking sector. The Russian money—what’s left of it—will be leaving. Years down the road, production of natural gas might kick in. Until then, Cyprus will be force-fed the Troika’s sacred medicine of “structural reforms,” so austerity, and privatizations of state-owned enterprises.

Markets soared when the deal was announced. But then a new reality interfered: Jeroen Dijsselbloem, Dutch Finance Minister and since January, President of the Eurogroup, said in an interview what should have been said years ago. Markets tanked.

“If there is a risk in a bank,” he said, “our first question should be ‘Okay, what are you in the bank going to do about that? What can you do to recapitalize yourself?’ If the bank can’t do it, then we’ll talk to the shareholders and the bondholders, we’ll ask them to contribute in recapitalizing the bank, and if necessary the uninsured deposit holders.”

He was extrapolating the Cyprus deal to banks elsewhere. Everyone who’d taken risks for financial gain would get whacked by the very risk they’d taken, before taxpayers, who hadn’t taken any risks, would get whacked. The process of bleeding the taxpayers for the benefit of investors had to stop, he said. And risks would have to be risks again.

What about other smaller countries with disproportionately large, highly leveraged banking sectors, like Luxembourg or Malta? They’d have to trim and strengthen their banks and fix their balance sheets before they get in trouble, he said. Investors should know that the ESM bailout fund would no longer “automatically” swoop in and make them whole.

“Now we’re going down the bail-in track,” he said. “It will force all financial institutions, as well as investors, to think about the risks they are taking.”

A sea change from Jean-Claude Juncker, his predecessor at the Eurogroup and Prime Minister of Luxembourg—the very country that Dijsselbloem had warned would need to strengthen its banks before they got in trouble.

But in his own back yard, Dijsselbloem did make whole certain investors when SNS Reaal, fourth largest bank and insurance group in the Netherlands was sinking into a morass of real-estate loans left over from a housing bubble. Under his direction, the bank was bailed out and nationalized in February, after already having been bailed out in 2008. It cost Dutch taxpayers €3.7 billion. A bankruptcy “would have unacceptably large and undesirable consequences,” Dijsselbloem explained at the time.

But stockholders were wiped out. And so were holders of junior debt! It sent tremors through the system. The needle that pricked the Eurozone bailout bubble.

Anecdotes were bandied about of mom-and-pop investors who’d lost their life savings because they’d bought these crappy junior bonds that had been touted as safe. They would have been worthless anyway in a bankruptcy, retorted Dijsselbloem and stuck to his semi-hard line—semi-hard because all depositors, insured or not, as well as holders of senior debt and covered bonds were still bailed out by taxpayers.

But the unwritten government guarantee on bank debt was off for the first time. Instead of flagellating his arms to justify why taxpayers had to bail out investors, he signaled that he wouldn’t tolerate a situation where the capital “at risk” wasn’t at risk. It would become the new way.

Or so you’d think. But last week, it was Germany’s turn to bail out a bank, mercifully obscured by the furor over Cyprus: HSH Nordbank, the world’s top ship-financing bank. The shipping-industry bubble that had turned into a crisis was sinking the bank. Due to overcapacity and low freight rates, ship owners could no longer service their loans. So HSH got bailed out by the states of Hamburg and Schleswig-Holstein that together own 90.69% of the bank. They’d raise state guarantees by €3 billion to €10 billion. Additional bailout aid would be considered. No haircuts for anyone. Except taxpayers. And like SNS Reaal, HSH had already been bailed out in 2008.

But when Dijsselbloem saw the markets swoon after his refreshing statements, he half-recanted—no one is allowed to prick the stock market bubble that central banks are blowing with such ardor, not even he. “Cyprus is a specific case with exceptional challenges which required the bail-in measures we have agreed upon yesterday,” he backpedaled hours later. “Programs are tailor-made to the situation of the country concerned, and no models or templates are used.”

Indeed. As the bank bailouts in the Netherlands and Germany have shown, every country will bail out its own banks however it sees fit—and taxpayers will continue to bear the brunt of the losses. But if the country isn’t big enough to bail out its own banks and requests an international rescue, the new model will be applied. These banks have now been marked. Of course, when the next megabank craters, when it isn’t a matter of a few billion, but a few trillion, all bets are off.